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Attention, there are three words generally considered to be offensive used in the following post.

You follow drugs, you get drug addicts and drug dealers. But you start to follow the money, and you don’t know where the fuck it’s gonna take you

– Det. Lester Freamon

This is a pretty famous quote from The Wire that’s been echoing in my head since last weekend, i.e. after the Cyprus crisis grabbed all the headlines. But unfortunately, unlike in the case of Detective Freamon, it wasn’t because I admired the meticulous and hard work people have been putting into trying to figure out the broad consequences.

Sure, the blogosphere’s reaction last weekend was marvelous and in my opinion helped to stabilise markets this week, but alas it’s not really an event in the eurozone if you can’t draw some explosive (and most of the time daft) parallels. Before we get to those I’d like to say a few words about origins of such a situation.

Haircut of depositors in Cyprus took the market by surprise. And by market I mean investors and traders but also the caste of research professionals whose job is to… well… try and forecast such events. Obviously, there is nothing wrong with being caught off guard from time to time and it’s the reaction to such a surprise that matters. The natural instinct of people who had not predicted what happened in Cyprus is to play it down and suggest to fade any adverse market reaction. The twisted logic here is “had it really been so important, I would’ve surely seen it coming and since I didn’t then it must be unimportant“. I’m sure there’s a name for such a behaviour in psychology but I can’t be bothered to search. In my opinion, this is the most common reaction.

If this first – let’s call it – line of defense fails and the person in question finally acknowledges that the surprising event could turn out to be quite important then another mechanism kicks in: they try and look for potential spillovers. The thinking is more or less that “ok, I may have dropped the ball here but have a look at those cascade effects that the market is missing“. I have been quite appalled to see that happening throughout the most of this week.

It usually starts with some pretty straightforward conclusions. In the case of Cyprus, people began assuming that we will inevitably have a run on the island’s banks and that it could lead to similar developments in Portugal, Spain, Italy or even Ireland. Right, because that’s what the Irish people do…

The next step in this “following the money” process was to figure out whose deposits will be cut in Cyprus. The answer to that seems to be “Russian” (although I would caution against making such a generalisation). This would look something like this…

You guys, let’s try and see how this affects Russia. Oh, here’s one: VTB is one of the most important Russian banks and it also has a subsidiary in Cyprus. Sell, Mortimer, sell! What? VTB bonds have sold off? Well then why don’t we sell bonds issued by VEB. It’s a big state-owned bank and while it has really nothing to do with Cyprus, there’s only a one letter difference to VTB so it’ll do. Oh, and did I just say it’s state owned? Mate, where’s your bid in 50m Russia30s?

Let’s move on. Cyprus is a small, country with problems in the banking system. Those problems partly stem from the immense inflow of dirty money in the past. After the Cypriot financial system reopens whatever is left of it will inevitably flee. What if it goes to Latvia, which is already a popular short-break destination for the Russians and which will soon enter the eurozone itself? (…unfortunately the person explaining to me what would happen next lost me completely and so I can’t follow this particular money trail to the end). By the way, the Latvian authorities had to start swearing that they wouldn’t end up like Cyprus. There’s no smoke without fire, anyone?

And finally, my very recent favourite…

There must be a small country in the eurozone, which has some problems with its banks and which we could sell. Hang on, what’s this little thing east of Italy that no one really knows about but occasionally makes some noises in the media? Slovenia! OMG, this is so exciting! Banks in Slovenia have NPLs reaching 20%? Some of them did not meet the ECB stress tests? The government recently collapsed and there’s a risk of an early election? I guess we’ve found a retirement trade. And don’t bother me with details that assets of the Slovenian banking system are only around 135% to GDP or that the total government financing needs for this year are projected by the IMF at 7.7% of GDP (slightly below Germany, Austria or Finland). Who cares that if the IMF’s forecasts are to be believed then Slovenia will meet both fiscal Maastricht criteria next year as it still has debt to GDP below 60%. And also, I’ve never believed in this cyclically-adjusted primary surplus mumbo jumbo…

Right, and when you’re done selling Slovenia, maybe we should look into Slovakia – there’s gotta be some connection!

I have started with a quote by Lester Freamon and I will end with one. Fifth series, episode three (entitled “Not for attribution”):